How Much Drag Can the UAE have?

A number of reports were released this week that cast more pallor over the UAE miracle.  First, Brad Sester and Rachel Ziemba estimate in a new report for the Council on Foreign Relations that the Gulf sovereign wealth funds likely lost as much as $82 billion in 2008, largely due to investment loses, despite record high oil prices.  ADIA, in particular, took a big hit.  Sester also estimates that the fund was never as big as other analysts projected and guesses that the fund did not exceed $330 billion by the end of 2008, down significantly from his estimates of $453 billion in 2007.  

A second report suggests that Dubai will witness a significant population outflow over the next few years as construction projects dry up.  Over 90% of Dubai's population is expat.  UBS estimates an 8% reduction in the number of expats living in the emirate in 2009 and a further 2% decline in 2010.   

Moodys issued a warning about deteriorating asset quality of loans made to Dubai developers in recent years.  The rating agency suspects that as the real estate markets continues to slow, those "opportunistic" developers who came to the market in the past 4 or 5 years might be tempted to default as property prices fall and liquidity dries up.  Moodys has downgraded its outlook on 4 UAE banks (Dubai Islamic Bank, Dubai Bank, Abu Dhabi Commercial Bank, and First Gulf Bank) because of this fear.

In a rare move, Dubai's government published a few details on the emirate's budget last week, projecting a 42% increase in government spending on infrastructure and economic services but anticipating a fiscal deficit of $1.14 billion.  Meanwhile, the emirate had to delay issuing a tranche of medium term notes worth about $4 billion citing little market demand with the credit crisis.

Finally, as if this all weren't enough bad news, the FT reports today that the threat of recession now hangs over the Gulf, one of the last regions thought to be able to manage the global downturn.  HSBC is forecasting the most severe retrenchment in GDP in 20 years.  HSBC believes that recession would be inevitable if oil drops to $25/barrel.

One can't help but wonder what the long term psychological impact of this current downturn will be for the Middle East.  True, things are made easier (if only from the perspective of justifying the downturn) by putting the numbers in global context.  This time, for better or for worse, the Middle East is linked much more closely with global fortunes than it was during the economic downturn of the 1980s.  This linkage raises the prospect of a faster recovery in coming years.  But I wonder if this will prove to be small consolation, especially when it comes to the UAE.  As I wrote in previous posts, the UAE (Dubai specifically) miracle inspired an entire region both with its audacious vision and later its funds to seek out an economic path forward that did not exclude the west but also did not rely on it for its own fortunes.  This may have been unique in the Arab world.  As Dubai is exposed as being over-extended, corrupt, and possibly without solid foundations, could other countries experimenting with economic freedoms reject all the lessons Dubai taught, even the good ones like individual, and foreign, ownership of property, a measure of cultural tolerance, openness to foreign investment, a willingness to experiment with new ideas?  For the economies of the region to be productive in the future, innovation on the personal, business, and government levels must be pursued.  The region is bound to fail if it simply tries to duplicate the development path of other countries of the world.  Dubai, if somewhat shallowly, offered a way beyond those truisms.  Let's just hope that doesn't all get lost in the coming months.